Rethinking Pakistan's fiscal model

Pakistan’s Budget FY27 should not begin with the question of how much additional revenue can be extracted from the economy. It should begin with a more fundamental question: what kind of economic incentives is the fiscal system creating?

Does taxation encourage investment, productivity, exports and formalisation? Or does it penalise scale, documentation and growth? Does fiscal consolidation strengthen competitiveness, or merely compress economic activity to meet short-term targets? And what institutional and economic cost is incurred to collect each additional rupee in revenue?

These questions matter because Pakistan’s fiscal challenge is no longer simply about insufficient taxation. Increasingly, it is about the quality and sustainability of the adjustment itself.

For years, Pakistan has relied on a narrow and distortionary model of revenue mobilisation: repeated taxation of the documented sector, temporary levies that become permanent, excessive dependence on withholding and turnover taxes, fragmented indirect taxation and quasi-fiscal extraction through energy pricing. The result has been a shrinking pool of compliant taxpayers who bear a disproportionate share of the burden, while investment and competitiveness remain weak.

The quality of a tax system cannot be judged only by how much it collects. It must also be judged by how it collects, from whom it collects, whether it rewards productive activity, and whether it strengthens or weakens incentives for long-term growth.

The imbalance is increasingly visible in the corporate sector. Pakistan’s effective corporate tax burden, after super tax and other levies, is higher than that of many regional competitors. Temporary taxes introduced during periods of stress have gradually become embedded within the permanent fiscal structure. Meanwhile, compliant firms continue to face delayed refunds, overlapping jurisdictions, extensive litigation and high transaction costs simply for operating formally.

This has consequences beyond business profitability. High and unpredictable tax costs reduce retained earnings available for reinvestment, weaken competitiveness, discourage scale expansion and increase the cost of capital. Over time, they undermine incentives for formal investment and long-term business expansion.

Pakistan increasingly taxes transactions, documentation and visible economic activity rather than actual profitability and capacity to pay. As a result, compliant firms often face higher costs, while informality retains economic advantages. At the same time, productive sectors continue to shoulder a disproportionate share of the fiscal burden while large areas of speculative and lightly documented wealth remain undertaxed. No country can sustainably industrialise while leaving major pockets of economic capacity outside effective taxation.

That is why the upcoming budget requires more than another round of revenue measures. It requires a shift in philosophy. The objective should increasingly be to build a broader, more predictable and less distortionary revenue base rather than relying on repeated extraction from already-documented sectors.

This means gradually reducing reliance on withholding taxes, presumptive regimes and turnover-based taxation, which function as substitute tax systems rather than genuine advance collection mechanisms. Such instruments may support short-term revenue collection, but they also raise costs for exporters, manufacturers and growing firms.

There is also a strong case for rationalising super taxes over time, reducing distortions such as the taxation of inter-corporate dividends, simplifying personal income taxation and gradually lowering excessively distortionary corporate and personal tax burdens as compliance and base-broadening improve. Pakistan’s GST structure has similarly become fragmented and compliance-heavy. A credible GST reform would require moving toward a simpler and more harmonised value-added tax structure with fewer exemptions, seamless input adjustment, faster refunds and lower compliance costs.

Simplification is not merely an administrative convenience. It is central to compliance itself. A system that ordinary businesses struggle to understand inevitably increases dependence on litigation, discretion and negotiated enforcement.

At the same time, broadening the tax base remains essential. Sustainable fiscal consolidation will not be possible if large segments of wholesale trade, retail, real estate and high-income informal activity continue to operate outside effective taxation. Provincial reform will be equally important, particularly regarding agricultural income taxation, land valuation and property taxation.

Yet meaningful reform requires more than simply expanding the number of taxpayers. It requires distinguishing between subsistence activity, small enterprise, high-income informal activity and genuine commercial scale.

Pakistan now possesses far greater data and technological capacity than a decade ago. The challenge is whether these tools support intelligent risk-based compliance rather than indiscriminate enforcement.

Predictability is equally important. Investors can often adapt to high taxation. What they struggle to adapt to is unpredictability – frequent policy reversals, delayed refunds, arbitrary interpretation and prolonged litigation that raise the effective cost of investment far beyond statutory rates. Aggressive assessments and disputed demands are not substitutes for sustainable revenue generation.

Tax reform alone, however, will not solve Pakistan’s fiscal challenge. Expenditure reform, which warrants deeper discussion in its own right, must become an equally important pillar of adjustment. The focus here, however, is principally on the tax architecture side of that broader reform agenda.

Even from a tax reform perspective, the interaction between fiscal policy and energy pricing cannot be ignored. Electricity pricing, meanwhile, has evolved into a multi-layer collection mechanism through which consumers are charged for costs unrelated to actual consumption. The increasing reliance on petroleum development levies has also blurred the line between taxation and pricing, using energy consumption as a vehicle for fiscal adjustment while quietly raising costs across the productive economy. While such levies may remain fiscally necessary in the near term, durable adjustment ultimately requires reducing dependence on energy-based extraction through broader tax reform, expenditure rationalisation and stronger documentation of untaxed sectors.

A more forward-looking fiscal strategy would gradually reorient spending toward infrastructure, logistics modernisation, export competitiveness, technology adoption and human capital while rationalising inefficient subsidies and non-productive expenditure.

Ultimately, the deeper challenge is one of tax morale and state credibility. Documentation should offer opportunity rather than disproportionate burdens. It should provide access to finance, legal protection, commercial credibility, digital integration and a predictable growth path. Citizens and businesses are more willing to comply when they believe the burden is shared fairly, public money is used responsibly, and the rules are applied consistently.

That is why transparency matters as much as enforcement. If taxpayers are asked to contribute more, they should also see visible improvements in infrastructure, education, health, governance and public service delivery. Taxation is sustained not only by coercion, but by legitimacy.

Budget FY27 will not solve all of Pakistan’s structural fiscal weaknesses in one year. No realistic budget can. But it can begin to set a clearer direction. It can signal whether policymakers intend to move away from distortionary extraction toward a broader, simpler, more predictable and growth-oriented fiscal framework. It can show whether the state is prepared to strengthen competitiveness while expanding compliance, improve the quality of expenditure while restoring investor confidence and support formalisation rather than unintentionally penalising it.

Ultimately, Pakistan’s fiscal challenge is not simply one of raising more revenue next year. It is about building a fiscal system that strengthens investment, encourages enterprise and restores confidence in the country’s long-term economic direction.

The writer is former adviser, Ministry of Finance. He tweets @KhaqanNajeeb and can be reached at: [email protected]

Disclaimer: The viewpoints expressed in this piece are the writer's own and don't necessarily reflect Geo.tv's editorial policy.

Originally published in The News